Alkemy (BIT:ALK) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Alkemy S.p.A. (BIT:ALK) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Alkemy

How Much Debt Does Alkemy Carry?

As you can see below, at the end of December 2020, Alkemy had €16.1m of debt, up from €11.5m a year ago. Click the image for more detail. But on the other hand it also has €18.9m in cash, leading to a €2.85m net cash position.

A Look At Alkemy's Liabilities

We can see from the most recent balance sheet that Alkemy had liabilities of €41.3m falling due within a year, and liabilities of €22.4m due beyond that. Offsetting these obligations, it had cash of €18.9m as well as receivables valued at €32.5m due within 12 months. So it has liabilities totalling €12.2m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Alkemy is worth €53.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Alkemy also has more cash than debt, so we're pretty confident it can manage its debt safely.

Pleasingly, Alkemy is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 103% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Alkemy's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Alkemy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Alkemy recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

Although Alkemy's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €2.85m. And it impressed us with its EBIT growth of 103% over the last year. So we don't think Alkemy's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Alkemy is showing 4 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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